Unit 23
A client's mixed margin account has the following positions: - Long, 100 XYZ with a current market value of $5,000 - Long, 300 ABC with a current market value of $16,000 - Short, 200 DEF with a current market value of $10,000 - Short, 100 GHI with a current market value of $8,000 The account has a debit balance of $8,000 and a credit balance of $22,000. What is the combined equity in the account? A) $17,000 B) $31,000 C) $9,000 D) $11,000
A) $17,000 There are two ways to compute the combined equity in a mixed (long and short) margin account. One is to add the positives and subtract the negatives. In this case, we are long (that is a plus for us) $21,000, and we have a credit balance (also a plus for us) of $22,000. That is a total of $43,000. Then, we owe (the debit balance) $8,000 against the long stock, and it will cost us $18,000 to buy back the short stock. That is a total of $26,000. Subtracting that from the $43,000 gives us a +$17,000. The other way is to take each account separately. In the long account, what we own ($21,000), minus what we owe ($8,000), equals $13,000 of long equity. In the short account, what we "own" is the $22,000 credit balance, and what we owe is the $18,000 market value of the short. That comes out to $4,000. Now, add those two together, and you get the same $17,000.
Which of the following cannot be purchased on margin? A) A long call option traded on the CBOE B) A listed bond C) A municipal bond D) An NYSE-listed stock
A) A long call option traded on the CBOE Listed call options (other than LEAPS) cannot be purchased on margin. Listed stocks and bonds are marginable under Regulation T and FINRA permits margin on municipal (and government) securities.
Trading securities involves certain expenses. Which of the following is not considered to be one of them? A) Advisory fees B) Markups C) Commissions D) Markdowns
A) Advisory fees Advisory fees are for advice, not execution of trades. When trades are made, if the firm is acting as a broker, the charge will be a commission; if acting as a dealer, it will be either a markup or a markdown.
When a securities firm is position trading, it is acting A) as a dealer. B) on principle. C) unethically. D) as a broker.
A) as a dealer. When a broker-dealer has a position in a security, it means the firm owns it or has sold it short (long or short position). In either case, the firm is acting for its own account and that means it is acting as a dealer or principal. There is nothing unethical about this; it is exactly what market makers do all day long.
When a security purchased on margin suffers a decline in market value, it may cause the equity in the account to fall to a level such that additional funds are required under the terms of the margin agreement between the client and the broker-dealer. The term that describes the request by a broker-dealer rather than an SRO for more money is A) house call. B) margin call. C) sell-out. D) Regulation T call.
A) house call. When the account value drops to a certain level, SRO rules require a maintenance call. When the broker-dealer sets that level more stringently (above that of the SRO), it is known as a house call. A margin call and Regulation T call are the same thing—the initial call for funds when purchasing on margin. A sell-out occurs when the maintenance (or house) call is not met.
Disclosure of payment for order flow is required A) on the trade confirmation. B) for trades in Nasdaq and NYSE securities. C) on the customer's account statement. D) on the order ticket.
A) on the trade confirmation. If applicable, payment for order flow must be disclosed on the customer's confirmation, not the order ticket or the account statement. This disclosure is required for trades in any Nasdaq but not NYSE securities.
An investor has her agent enter a sell stop order at 60, limit 60. Following the order entry, trades occur at 62.12, 60, 59.95, 60.06, 61. More than likely, the investor received A) 59.95 B) 60.06 C) 60 D) 61
B) 60.06 This is really two orders. The first is to "stop" at 60. That is, once the stock trades at 60 or lower, enter my order. That second order is a sell, but with a limit of 60. So the first time the stock hits 60 (or less) is the trade at 60. That triggers the sell limit. The next trade is a 59.95. Because the limit order is saying, "Get me 60 or higher, the 59.95 is not an acceptable price." But, the next trade, 60.06 will meet the client's goal of receiving no less than 60.
A client with a bullish outlook on a particular stock would be able to benefit most from taking which of the following actions? A) Entering a sell limit order B) Buying the stock on margin C) Entering a buy stop D) Selling the stock short
B) Buying the stock on margin If one is bullish on a stock, the advantage of purchasing on margin is due to the leverage employed. In other words, by putting up half the money, you get 100% of the growth. Selling short is a technique used by investors who are of the opinion that the market price of a stock is going to fall.
A client of your broker-dealer, currently long 1,000 shares of DEF Corporation common stock, wishes to liquidate the position. Based on the following market maker quotes, it would be expected that the firm's trader would direct a market order to A) MMB: 9.65 - 9.75, 10 x 10. B) MMC: 9.75 - 9.85, 20 x 20. C) MMA: 9.65 - 9.85, 5 x 5. D) MMD: 9.75 - 9.90, 5 x 10.
B) MMC: 9.75 - 9.85, 20 x 20. A market order to sell 1,000 shares should be directed to the market maker with the highest bid price that is firm for at least 1,000 shares. The highest bid price is $9.75 by both MMC and MMD, but MMD's quote is only firm for 500 shares.
It is often said that the backbone of the over-the-counter market is the market maker. A good description of a market maker would be A) an employee of a listed exchange. B) a broker-dealer who stands ready to buy or sell at least the standard unit of a specific stock traded in the over-the-counter market. C) an investment banker who participates in a firm underwriting. D) a member of FINRA.
B) a broker-dealer who stands ready to buy or sell at least the standard unit of a specific stock traded in the over-the-counter market. This is the basic definition of a market maker. Specialists (now technically called designated market makers or DMMs) perform essentially the same service on the listed exchanges. Although all OTC market makers are members of FINRA, being a FINRA member does not define a broker-dealer as a market maker.
A broker-dealer acting as a principal in a trade would A) add a markup to the bid price when offering shares to a client B) add a markup to the offering price when selling shares to a client C) must always disclose the amount of markup on a client's confirmation statement D) must disclose to clients the amount of earnings he made on principal transactions in excess of the amount he would have made had he charged a commission
B) add a markup to the offering price when selling shares to a client When selling a security to a public customer, the broker-dealer adds his markup to the ask price (offer price), not the bid price. A broker does not add a markup to the bid price when buying shares from a client; the broker-dealer would mark down the bid price. Unlike commissions, which are always disclosed on the trade confirmations, only for certain categories of securities is the markup or markdown shown.
The term used to describe a broker-dealer contacting a margin account client with a demand for additional funds is A) market call B) maintenance margin C) margin call D) Reg. T call
B) maintenance margin The original call for funds is the Reg. T or margin call. But, when the call is for additional money, it is known as maintenance margin. This generally occurs when the value of the collateral in the account has fallen sharply.
All of the following information must be included on a customer's order ticket except A) terms and conditions of the order (e.g., limit). B) payment for order flow if applicable. C) time of receipt of the order. D) if a sell order, is it long or short.
B) payment for order flow if applicable. Payment for order flow is noted on the customer confirmation, not the order ticket. The order ticket, or order memorandum, will be time stamped with the time the order was received. Every sell order must indicate if it is a long or short sale. Terms of the order include notations if it is a market, limit, or stop order.
In a margin account, broker-dealers lend money to clients to enable them to leverage their investments. The account document that is evidence of the debtor-creditor relationship is A) the hypothecation agreement. B) the credit agreement. C) the loan consent agreement. D) the IOU agreement.
B) the credit agreement. The credit agreement, sometimes simply referred to as the margin agreement, is the written agreement between the client and the broker-dealer evidencing the loan. The loan consent agreement is the optional portion of the account documentation which allows the broker-dealer to lend out the client's margin securities. The hypothecation agreement allows the broker-dealer to re-pledge, (rehypothecate), the client's securities as collateral for the money it borrows at the broker call loan rate.
Which of the following orders would be used to protect a short sale profit? A) A sell stop B) A sell short C) A buy stop D) A buy limit
C) A buy stop For a short sale to earn a profit, the current market value must be lower than the sale price. An investor must buy the stock at a lower price to realize a profit. To protect denotes buying if the market starts to rise. Therefore, a buy stop would be entered above the current market value to protect the profit and trigger a purchase in the event the market starts to rise.
Under the Securities Exchange Act of 1934, a market maker is A) a marketplace to bring together buyers and sellers of securities B) any person who buys and sells securities for his own account or for the accounts of others C) a dealer who holds itself out as being ready at all times to buy or sell shares of a specified security at a quoted price D) a security in high demand
C) a dealer who holds itself out as being ready at all times to buy or sell shares of a specified security at a quoted price A market maker is a dealer that holds itself out as being willing to buy or sell a security at a quoted price on a regular and continuous basis.
Some market makers, in an attempt to increase order flow, will pay other broker-dealers for routing customer orders to them. This is known as A) soft-dollar compensation. B) third-party payments. C) payment for order flow. D) interpositioning.
C) payment for order flow. Payment for order flow can be beneficial for small firms that cannot handle large numbers of orders. Pulling together lots of orders and sending them to another firm to be executed can help keep costs down. The market maker benefits from added share volume enabling it to compensate the firms directing the business its way. When acting in an agency capacity for a customer, a BD cannot place a third party between itself and the best available market; they must go directly to the market maker. That is the unethical practice of interpositioning (and is an example of the exam using a term that you likely don't know as a distractor). Soft dollar compensation is between a BD and an investment adviser and, unlike payment for order flow, does not consist of a monetary payment, hence the term soft dollar.
Margin regulations are determined by the Board of Governors of the Federal Reserve System. The authority for them to do so is found in A) the Maloney Act of 1938 B) the Federal Reserve Act of 1913 C) the Securities Exchange Act of 1934 D) the Securities Act of 1933
C) the Securities Exchange Act of 1934 The Securities Exchange Act of 1934 contains the authorization for the Fed to regulate the use of credit in the securities business.
A client calls to tell you that he has inherited some stock from his grandmother and would like to sell it. After a bit of research, you discover that the stock is thinly traded on the OTC Pink Market. This means A) the spread between bid and ask is likely to be less than normal. B) the stock is probably worthless. C) the spread between bid and ask is likely to be larger than normal. D) the spread between bid and ask will be normal.
C) the spread between bid and ask is likely to be larger than normal. Thinly traded does not describe the value of the security. It does mean that market makers take additional risk in maintaining an inventory and, to compensate, have larger than normal spreads. This is one of those situations where a higher than normal trading cost is not considered unethical, as long as it is disclosed in advance.
All investing carries risk of loss. Some positions have much higher risk than others. Among the riskiest is selling stock short. Which of the following types of orders would you recommend to a short seller as a potential hedge against loss? A) Sell limit B) Buy limit C) Sell stop D) Buy stop
D) Buy stop The risk to a short seller is to the upside (there is, at least theoretically, no limit as to how high the stock's price can go). Remember, a short seller is obligated to buy back the shorted stock. Therefore, we want to place an order that will enable the customer to purchase the stock before the price rises too high. That reduces the choices to the two that include the word, buy (we've already sold the stock, selling it again doesn't help). To protect against an increase to the stock's price beyond the point the investor is willing to lose, it is wise to enter a buy stop order at that price. If the stock should reach that price, the order is triggered, a market order is entered, and the short position is closed out. This is why stop orders are usually referred to as stop loss orders; they keep you from losing any more money. A buy limit order is always placed below the current market. That won't help the short seller when the price of the stock rises.
It would be correct to state that 1. the specialist stands ready to buy or sell stock on the floor of an exchange in an effort to keep an orderly market 2. the specialist stands ready to buy or sell stock on the over-the-counter market in an effort to keep an orderly market 3. the market maker stands ready to buy or sell stock on the floor of an exchange in an effort to keep an orderly market 4. the market maker stands ready to buy or sell stock on the over-the-counter market in an effort to keep an orderly market A) II and III B) II and IV C) I and III D) I and IV
D) I and IV The specialist performs his activities on the floor of an exchange, while the market maker performs a similar function in the OTC market. Note: The term specialist has been replaced by designated market maker (DMM), but specialist might still appear on the exam.
Which of the following securities can legally be purchased on margin? A) Units of a variable annuity issued by an insurance company authorized to do business in the state B) Put options where the underlying common stock is listed on the New York Stock Exchange C) Preemptive rights to acquire shares of a stock traded on the New York Stock Exchange D) Warrants exercisable into shares of a stock traded on the Nasdaq Stock Market
D) Warrants exercisable into shares of a stock traded on the Nasdaq Stock Market Warrants, but not rights, may be purchased on margin if the underlying stock is traded on the NYSE or the Nasdaq. No insurance product is marginable and the same is true for options. LEAPS are option contracts that are marginable, but the question would have to specify that the contract was a LEAPS.
A Nasdaq market maker buys 1,000 shares of stock from a customer at its bid to satisfy a customer order. This is an example of A) a block trade. B) a market order. C) an agency trade. D) a principal trade.
D) a principal trade. The market maker is acting in a principal (dealer) capacity. You should remember that a block order is a minimum of 10,000 shares not 1,000.
Broker-dealers provide a bid and offer price when functioning as market makers. In this context, A) the bid price represents market maker's selling price and the offer price is the price the market maker is willing to pay for the stock. B) the bid and offer price refer to the price the market maker is willing to pay for the stock. C) the bid and offer prices refer to the market maker's buying and selling prices including commissions. D) the bid price represents the price the market maker is willing to pay for the stock and the offer price is the market maker's selling price.
D) the bid price represents the price the market maker is willing to pay for the stock and the offer price is the market maker's selling price. Marker makers provide a two-sided quote. Because market makers stand ready to buy and sell the specific security, they provide a bid price, the price the firm is willing to pay for the stock, and the offer price, the price they are asking to receive when selling the stock. Market makers do not earn a commission; they charge a markup or markdown.
In the securities industry, the term contra party refers to A) the person identified on the trade confirmation as a broker B) a securities regulator who begins an investigation against a securities professional C) the person on the other side of a civil suit D) the person on the other side of the trade
D) the person on the other side of the trade Contra party is defined as the broker-dealer or customer to whom a person has sold securities or from whom a person has purchased securities—they are on the other side of the trade.
